Prof. Bryan Caplan

Econ 849

Fall, 2001


Week 6: Redistribution, Divided Government, Interest Groups, and Rent-Seeking

I.                     Normative Redistribution

A.                 There are five popular normative rationales for redistribution.

B.                 Rationale #1: Redistribution as a return on investment. 

C.                Problems:

1.                  Why can't people invest on their own?

2.                  Actual returns don't match contributions very well.  The first recipients of SS got a windfall; present recipients get a below-market return.

C.                Rationale #2: Redistribution as insurance. 

D.                Problems:

1.                  Why can't people buy their own insurance?

2.                  Premiums and benefits rarely adjust for risk like a real insurance policy. 

E.                 Rationale #3: Egalitarian redistribution. 

F.                 Problems:

1.                  Programs that benefit the elderly actually don't do this.  Why?  Because the rich live longer than the poor on average, so they wind up collecting more money from SS and Medicare.

2.                  If this were the real reason for redistribution, none of it would be spent on the relatively poor people in the U.S.  It would go to absolutely poor people in other countries.

G.                Rationale #4: Externalities.  Redistribution reduces crime, begging, and so on.

H.                 Problems:

1.                  Are the elasticities even close to high enough to make this a good idea? 

2.                  Will the elderly turn to crime?

II.                   Redistribution in Practice

A.                 I would argue that real redistribution is instead based primarily on paternalism (people are too dumb to plan for their retirement and health care) and tribalism (taking care of our own).

B.                 In the U.S. at least, most redistribution focuses on the elderly: SS and Medicare amount to 35% of the budget.  The American poor get about 13% of the budget.

C.                Much of the money spent on the old and poor is for health care, which probably does little to benefit them relative to the cost. 

D.                This is particularly clear for the old: Health care for the elderly is very expensive, but at best slightly lengthens what are probably the worst years of your life. 

E.                 The same basic argument works for the poor.  They value health care less than the rich because they have more pressing priorities.

F.                 What are the DW losses of the level of redistribution?  The form?

G.                Immigrations restrictions are an indirect form of redistribution to low-skilled Americans at the expense of foreigners.

H.                 Many favor immigration restrictions because people are "coming here to collect welfare."  Others frankly argue that immigration should be stopped because it hurts wages for low-skilled Americans.

I.                     Either way, the idea is to help relatively poor Americans at the expense of absolutely poor foreigners, making a mockery of egalitarian rationales for redistribution.

J.                  What are the DW losses of immigration restrictions?

IV.               Principal-Agent Problems, Multiple Agents, and Overlapping Principals

A.                 We have already thought about simple principal-agent problems, where there is one principal (a shareholder or voter) who tries to set good incentives for a single agent (a manager or politician).

B.                 In many contexts, the problem is more complicated because there are multiple agents and overlapping principals.

C.                The most natural intuition is that agents' performance falls because it is hard for principals to decide who to blame.  And if there are a lot of blameless agents, imposing probability multipliers on punishment may be a bad idea too.

D.                But there are a variety of contrary intuitions:

1.                  Avoiding concentration of power

2.                  Increasing stability

3.                  Efficiency of specialization

K.                 Many political systems appear to act on one or more of these contrary intuitions by setting up a division of powers.

V.                 Division of Powers and Minimum Winning Coalitions

A.                 In the standard median voter model, whoever wins the election imposes its will.

B.                 In the U.S. and many other systems, political outcomes are a compromise between several different "winners."  How do these compromises work?

C.                One popular answer appeals to the notion of the "minimum winning coalition."  (MWC)  A minimum winning coalition is the smallest group large enough to impose its decision.

L.                  Intuition: Why include more people in your winning coalition than you need?  That means dividing up the same pie between more people.

VI.               Bicameralism and MWCs

A.                 To simplify the analysis, imagine that you need a simple majority of two legislative houses to pass a bill (nothing more).  The MWC is 50%+1 of the lower house and 50%+1 of the upper house.

B.                 So what happens?  Following Cooter, imagine putting median lower and upper ($L, $U) house preferences for spending on a line, and assume that $L<$U.  Similarly, put $L0 and $U0 to indicate the spending levels that leave the median lower and upper house legislators indifferent to spending $0.

C.                Cooter labels the region between $L and $U as the Pareto set.  Movement within this set makes one bargainer better off and the other worse off.  Moving from outside the Pareto set to inside, in contrast, makes all bargainers better off.

D.                Similarly, he labels the region between $L and $L0 as the bargain set.  This is the part of the Pareto set that  both sides prefer to $0. 

E.                 Given the political rules, policy must lie in the bargain set. 

F.                 What does moving from one to two houses do?  It (weakly) tends to reduce the total level of spending because spending will never rise above the lower of $L0 and $U0.

G.                But this is not the only effect.  It could conceivably increase spending by bargaining the lower house to accept something between $L and $L0.  With only the lower house, you would get $L exactly.

H.                 These effects are likely to matter more if the lower and upper houses represent constituencies with very different preferences.   

VII.              Presidential Veto the MWCs

A.                 First imagine a situation with one legislative house and a president with absolute veto power.  ($E<$L) What happens?

1.                  It looks just like the previous situation.

B.                 Next, imagine adding a president with absolute veto power to a system with two houses. 

C.                Adding the president (with $E and $E0) tends to expand the Pareto set but shrink the bargain set.

D.                Last, imagine a situation with one house and a President with a 2/3 over-rideable veto.  This tends to expand the bargain set, because the President is no longer absolutely necessary for legislation to go through. 

E.                 Just add the preferences of the 33rd percentile of the legislature to the diagram.  If these are closer to the median legislator than the President, they can strike a bargain without him.

VIII.            The Role of the Judiciary

A.                 People frequently think of the judiciary as mechanically "interpreting" laws.  But judges' political views often seem to affect their decisions.

B.                 But judges' "interpretations" can be overruled by further legislation.  So can judges really affect legislative outcomes?

C.                Yes, as long as they keep their ruling within the Pareto set

D.                Imagine, for example, that two houses of Congress finally agree to spend $X dollars, which lies somewhere between $L and $U.  But a dispute arises and a court gets to rule on the "true meaning" of the bill.

E.                 Even if the judiciary ruled for $U exactly, the lower house would be unable to get the upper house to pass another bill "clarifying" the meaning of the first bill.

F.                 Ex: Both Houses of Congress and the President sign an anti-discrimination bill that bans any consideration of race.  Could the Court reinterpret this measure to allow discrimination against whites?  Yes, as long as ONE of the three governing bodies actually prefers the court's version.

G.                How do courts' interpretative abilities work with forward-looking legislators?  Use backwards induction.

IX.               Special Interests and the Median Voter Model

A.                 The Median Voter Model makes no room for "special interests."  Voters get what they want.

B.                 But observers have frequently argued that "special interests" - small groups of activists "behind-the-scenes" - foil the majority's wishes.

C.                Definition: A special interest is any organized group with preferences different from the median voter's.  The goal of a special interest group is to pull policy in their preferred direction.

D.                The distinction between mean and median preferences suggests the possibility that this is actually efficient!

E.                 If interest groups disagree, moreover, they may directly cancel each other out. 

F.                 Similarly, if there is only "so much money to go around," in the budget interest groups may indirectly cancel each other out.  More money for schools means less for the environment, or defense, or something else.

G.                Leaving all this aside, how exactly could special interests exert influence anyway?  Doesn't political competition prevent it?

X.                 Campaign Contributions, Political Advertising, and Rational Ignorance

A.                 The most popular answer is campaign contributions.  Special interests move policy away from voter preferences by making donations to politicians.

B.                 In many political economy models, policies lie somewhere between the median voter's wishes and special interests' wishes.

C.                Politicians then use these donations to "buy votes."  Political advertising is the standard example here.

D.                Why would political advertising work?  The usual answer appeals to voters' rational ignorance.  The ads are aimed at uninformed voters who are easy to sway.

E.                 While this story sounds good, does it really make sense?  Why do uninformed voters pay any attention to ads, if they are typically funded by subversive special interests?

1.                  Compare this to buying a used car.  Just because the buyer is ignorant, does he have to idiotically believe every word the seller tells him?

F.                 Empirical studies of campaign finance have often found it difficult to pick up its effect.

XI.               Concentrated Benefits, Diffuse Costs, and Asymmetric Information

A.                 A more general story that builds on voters' rational ignorance goes by the name of "concentrated benefits, diffuse costs."

B.                 Simple idea: Special interests are well-informed because they have so much riding on the political outcome.  Regular voters aren't informed because they have so little riding on it.

C.                Thus, special interests find it much easier to pressure politicians than voters.  They can say "Vote against us, and we'll withdraw all of our support.  And if you support us, the voters will never know."

D.                Suppose, for example, that voters are selfish, and 90% are uninformed.  Then the 10% of informed voters could in essence tell politicians: "We'll vote for whichever candidate promises us the most, not the candidate who will do the best job overall."

E.                 But critics doubt that organizing such a "grand conspiracy" would succeed. 

1.                  Wouldn't information leak out? 

2.                  What about optimal punishment?

3.                  In markets, consumers' standard response to asymmetric information is to demand LESS.  Similarly, shouldn't voters' response to CB/DC be reduced willingness to vote for government programs?

XII.              Lobbying in Equilibrium: Rent-Seeking and Rent Dissipation

A.                 Gordon Tullock's deep insight: lobbying/rent-seeking is a competitive industry like any other.  If lobbying earns a 10% rate of return, and the standard rate is 5%, this will induce "new entry" into the lobbying "business."

B.                 Firms will keep entering this "arms race" until the net profits of the privilege are zero.  This happens when the total costs of lobbying equal the total value of the monopoly privilege!  This is known as "full rent dissipation."

C.                The government could award monopoly privileges by taking bids (or bribes) rather than listening to lobbyists.  But then, Tullock pointed out, this intensifies political competition; if people can get rich in politics, they will pay more to win a seat.

D.                This even works in a dictatorship or monarchy; if the dictator can get rich by awarding monopoly privileges, this strengthens the incentives of "upstarts" to try to seize the throne, stage a coup, etc.